selling deep in the money calls strategy

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Looking at another example, a May 30 in-the-money call would yield a higher potential profit than the May 25. Why? She will keep the stock, with the plan to sell another call option soon at an opportune time, anticipating the stock will move back toward the high end of its’ trading range within a week or two based on the stock’s recent trends. Your email address will not be published. By using a DITM strategy, you can accomplish several things: Lower your cost of entry into a stock that … The strategy I implement with my deep in-the-money calls is to buy with a strike date four to seven months in the future in order to provide leverage and downside protection over a long period … Potential Return on in-the-Money Call WritesAs you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). Sell a Call Option with More Time Value, from selling the call options. . The six-month (December) deep-in-the-money 1050 call is now trading for $131, meaning you can initiate the long side of the trade for $13,100 instead of $115,500. This is calculated based on taking the premium received ($120) and dividing it by the cost basis ($2,380), which yields +5%. Make Money By Spending Less. Read my related post Does Living Off Covered Calls Really Work? During times of high volatility, for example, I have structured covered calls with a very low risk loss potential of about 1% while using stop losses and selling covered calls against a diversified portfolio of etfs for income. Downside protection from the sold call offers only 6% of cushion, after which the stock position can experience un-hedged losses from further declines. And, of course, some stocks do well during bear markets. Gimmicky strategies of covered call buy-writing are not necessarily the best way to go. This is why I often write that selling covered calls can be an ideal income stream for investors who already have stock market risk in their portfolio anyway. Also remember that bear markets have, in hindsight, usually been. Note that if you’re new to stock charts, while technical analysis can seem daunting, very basic technical analysis can be an incredibly valuable tool for evaluating the best covered call strategies. . In this case, Alex would have made $560 on the overall position as follows: Net Profit per Share                   $.90, Number of Shares                       600, Total Profit                           $560. Option 3. ♦Income Stream Tip♦  Note that decay of time value is a huge advantage for option sellers vs option buyers that naturally happens with covered call writing. She wanted to generate some income from the stock, so she sold 6 June call options with an $18 strike price for $1.40 each. Remember that a core principle at Retire Certain is to decide how much time you want to spend on your income streams first, and then implement income generating and wealth building strategies from your lifestyle decision so you can live how you want. and Stocks That Went Up in 2008 or What Goes Up When Stocks Go Down? What I do, and what you should do, is invest using deep-in-the-money covered calls (DITM). These conditions appear occasionally in the option markets, and finding them systematically requires screening. The stock can fall 38% and still not have a loss, and there is no risk on the upside. While I’m an AFC, I mostly write based on my 40 year investing adventure; I don’t manage wealth for others although I have hired a few financial advisors over the years. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a, The option buyer could simply buy the stock for less than the strike pri. you may have an insight into an upcoming event. An employee stock option (ESO) is a grant to an employee giving the right to buy a certain number of shares in the company's stock for a set price. Selling call options against shares you already hold brings in guaranteed money right away. This was the case with our Rambus example. However, for retirees and others living off investments who count on covered calls for income, bear markets can present a real challenge. Understanding the Strategy May Be More Straightforward by Using an Example: Step … Let’s look at the third possible outcome at option expiration with her Retire Corp in the money covered call strategy. The near … Option 2. Therefore, the maximum gain to be made writing in-the-money calls is limited to the time value of the premium at the time of writing the call. While there is less potential profit with this approach compared to the example of a traditional out-of-the-money call write given above, an in-the-money call write does offer a near delta neutral, pure time premium collection approach due to the high delta value on the in-the-money call option (very close to 100). The income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income! The question presented was the following strategy, a “can’t-lose” approach to covered call writing? Stock is trading at 16.91 with $1 increment strikes so any option with a strike of 15 or less … A ratio call write is an options strategy where one owns shares in the underlying stock and writes more call options than the amount of underlying shares. The Bottom LineCovered-call writing has become a very popular strategy among option traders, but an alternative construction of this premium collection strategy exists in the form of an in-the-money covered write, which is possible when you find stocks with high implied volatility in their option prices. Alex can sell another call option for the next month against her shares in Retire Corp. ince the stock price has dropped from her purchase price of $18.50. Read my related post Problems with Covered Calls. In this next possible outcome, assume Retire Corp closes below $18, or deep in the money. ♦Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news. Read my related post How to Create a Wealth Plan that explains this more. This is offset, however, by the reality that managing unexercised covered calls doesn’t generate as much income as new monthly trades. Figure 1 - RMBS May option prices with the May 25 in-the-money call option and downside protection highlighted. What a savings! Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. If the stock drops to $97 by the option expiration date, the option won’t be exercised. One last advantage for in the money covered call strategies is that having all your covered calls exercised each month provides capital for fresh positions without having to allocate more capital to stocks designated for covered calls. If you hate managing covered calls, in the money strategies may be best for you since more in the money covered call positions get exercised than at the money or out of the money covered call strategies. There is a trade off for this income, however, and more to consider as explained below. And since the market is declining, it is harder to sell call options near your stock purchase price since the option prices have declined with the stock price. You buy the stock and sell covered calls that … If you enjoy researching stocks and easily find new ideas for covered calls, you may want all your covered call positions to get exercised so you can enter new positions more often. The, Higher Income from In the Money Covered Calls. In the money covered calls, however, tend to be the least risky of the three covered call strategies, and here’s why: In the money strategies offset stock cost more than other covered call strategies because the covered call writer gets the highest premium when selling in the money options, as explained ahead. Our Income Stream, Wealth Building Adventure Later in Life. Income from Covered Calls Vs Capital Gains. Alex could still use any of the four options available from above but the outcome will be less favorable since the stock price dropped more before the option expiration date. Selling deep in-the-money call options represents an innovative approach to obtaining high probability yields. She would be close to breaking even on the overall position if she sold her stock at option expiration. Then let’s look at how an in the money covered call strategy works and a specific in the money covered call strategy with the three potential profit or loss outcomes based on the underlying stock price at the option the expiration date. Now that you’ve seen the factors to consider before choosing an in the money covered call strategy specifically, let’s look at the math with an example. Buying options is a lot like gambling at the casino. Fortunately, there are some advanced covered call management strategies that can be used during stock market downturns. Buying options is a lot like gambling at the casino. You’re betting for a specific outcome … Required fields are marked *. Click Any Topic Below to Go Straight To It. Based on your overall wealth plan, you may find that you want income more than capital gains. It’s a quality stock, but based on the stock’s chart, she thinks the stock has a good probability of dropping in value over the short term because it’s at the top of its’ recent trading range. Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium. This is not common but stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. So, "deep in the money" call options would be calls where the strike price is at least … makes more sense to sell in the money covered calls than. If used with margin to open a position of this type, returns have the potential to be much higher, but of course with additional risk. This is because the entire position can be entered into based on the optimal income initially. This phrase applies to both calls and puts. Ali’s example gives you a basic and broad idea of why a covered call seller may choose an in the money covered call strategy. income while reducing or eliminating capital gains. An option is said to be "deep in the money" if it is in the money by more than $10. However, in order to compare a monthly or six week return to an annual return, such as dividend income of 3% a year, it helps to calculate covered call returns annualized. As you can see in Figure 2, with the May 25 in-the-money call write, the potential return on this strategy is +5% (maximum). Plus, … In this case, the option buyer may or may not “exercise” the call option. Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range. For a more comprehensive breakdown on the different strategies Click Here To Read… Selling Options To Boost Your Income . You can see why covered calls can be a great income generator for stock investors who are already exposed to stock market risk anyway. Either way, Alex kept the $800 from the option sale. Any upside move produces a profit. This will be the underlying stock against which she sells call options for some extra income. Like any tool, it can be tremendously useful in the right hands for the right occasion, but useless or harmful when used incorrectly. Risk is permanently reduced by the amount of premium received. While in the money covered call strategies may do best in declining stock markets, out of the money covered calls aren’t ideal either on declining stocks or etf’s. Hire a financial professional if you think you need one. This allows you to sell call options repeatedly against the same stock position, thereby reducing the need to find additional suitable stocks. ♦In My Experience♦ I usually enter in the money covered call strategies, however, with the expectation that the stock will temporarily decrease in value. This gives the call purchaser the right to buy the stock from Alex at $18 on the third Friday of June (option expiration), or June 15 in that particular year. A fence is a defensive options strategy that an investor deploys to protect an owned holding from a price decline, at the cost of potential profits. The good thing for covered call investors is that stock and option commissions have gotten very cheap over the past two decades due to competition, especially with the ability to buy and sell securities online. But the good thing is that Alex gets to keep the $ 1.40 for selling the option, which reduces her Retire Corp position cost per share cost to $17.10. are profitable, but many are, and they can be an excellent income source. For options, both a call and a put option can be in the money. If the overall market is trending down, however, it usually makes more sense to sell in the money covered calls than out of the money covered calls as explained below, IF you choose to stay invested in stocks despite the decline. Of course, there is no way to know this with certainty but the stock chart can provide probabilities. ers living off investments who count on covered calls for income, bear markets can present a real challenge. stick with me because it’s important because it makes the math on in the money covered call strategies easy to understand. In this case, Alex would have made $800 from selling the call options. aving all your covered calls exercised each month provides capital for fresh positions, without having to allocate more capital to stocks designated for covered calls. * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) Again, this means that in the money covered call strategies generate higher income than out of the money covered call strategies. Based on your overall wealth plan, you may find that you want income more than capital gains. or out of the money covered call strategy. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Covered Call Income Generated from Retire Corp. 1. brokerage account for the sale of the option, generating strategy for those living off investments, c. 00 covered call income is from the following calculation: How Many Stocks Does One Option Contract Represent? Before deciding whether to use an out of the money, at the money, or an in the money covered call strategy, consider the above factors, overall stock market direction and your own financial goals for building wealth or income. Now a deep in the money option usually has a delta of .60 or above meaning that the option will move $.60 cents for every dollar move in the underlying stock. And who doesn’t want higher income for the same amount of capital at risk? You’re betting for a specific outcome with odds of winning a mere 25% to 40%! You can then sell the underlying stock, buy back the short calls … Investopedia uses cookies to provide you with a great user experience. If so, this loss will offset the income generated from selling the call option as explained more ahead. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options. The option buyer could simply buy the stock for less than the strike price of $18 so there would have been no reason to exercise the option. Put selling by using deep in the money puts is a … It closed at $17.16. Likewise, offset, however, by the reality that managing unexercised covered calls, doesn’t generate as much income as new monthly trades. Also remember that bear markets have, in hindsight, usually been excellent opportunities for covered call strategies once a sideways or bull market resumes. As you can see in Figure 1, it would be possible to sell a May 55 call for $2.45 ($245) against 100 shares of stock. They are addicted to the thrill of the game as they continue to look for that next explosive trade. Alex can sell a call option for two or more months out, increasing the option premium by increasing the time value. Sometimes you can even find a deep in the … Assume the option buyer did not exercise the option by buying the stock. Below are the other factors for when to use an in the money covered call strategy, so keep reading. At this point, Alex has several options you can see below. Remember, the prior month, the stock was at $18.50. ♣  It’s super important to remember that when you sell in the money covered calls, you know that you may have to sell the stock at a loss. Cash collected up front can be … Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. Unless Alex buys back the call option, what happens on options expiration depends on the price of the stock on June 15, the third Friday in June that year, so let’s look at that next. Everyone knows what deep in the money calls means. This is why doing the option expiration math for all 3 potential outcomes is important before making any covered call investments. Remember, a lower overall stock cost lowers risk. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get, If you hate managing covered calls, in the money strategies may be best for you since mo, in the money covered call positions get exercised, than at the money or out of the money covered call strategies, This is simply because the strike price is lower with an in the money covered call strategy than it is with an at. Does Living Off Covered Calls Really Work? Trade deep in-the-money calls to increase yield on a stock and lower the downside risk. Instead of selling another call option right after option expiration, Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium. When found, an in-the-money covered-call write provides an excellent, delta neutral, time premium collection approach - one that offers greater downside protection and, therefore, wider potential profit zone, than the traditional at- or out-of-the-money covered writes. This would be offset by a loss on the stock of $300 ($.50 per share assuming she sold it at $18 on Monday morning following option expiration) leaving her with a profit of $500. ♦Wealth Building Tip♦ All investments are bad if they take an investor outside of acceptable risk while too little risk can hinder investment returns. If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. . With this in mind, she decides to sell a call option with a $99 strike for $2 instead of a call option with a $100 strike for $1.50 agsint her Income Streams, Inc. shares. By using Investopedia, you accept our. That may not sound like much, but recall that this is for a period of just 27 days. They should be considered based on your own situation and commission structure. The Problem. This strategy is commonly used when the call writer expects the stock price … ♦Income Stream Tip♦  Selling call options on high dividend stocks can make sense for investors who always want at least a little income from stocks. Remember, the further away the strike price is above the current stock price, the less income generated since the option premium (price) gets lower as it moves further up and away from the stock price. (Read my related post What Goes Up When Stocks Go Down?). The worse thing for covered call writing is, bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. As you can see, all the profit from this covered call investment came from the sale of the option premium, as is often the case with in the money covered call strategies. I like to assess this from a stock chart, as well as fundamentals such as earnings and dividends, while also factoring in the risk I am willing to accept. A call option is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period. Note that many covered call writers prefer to open new positions every 4 to 6 weeks for minimal effort with good income, but there are many other covered call time frames, including weekly options, how much time you want to spend on your income streams, and wealth building strategies from your lifestyle, Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range, f you’re new to stock charts, while technical analysis can seem daunting, v. ery basic technical analysis can be an incredibly valuable tool for evaluating the best covered call strategies. Read my related post on the cash allocation in a portfolio. On that strike, there is $260 in time premium available. Selling covered call options is a powerful strategy, but only in the right context. of $18 so there would have been no reason to exercise the option. This is because the cost basis is much lower due to the collection of $1,480 in option premium with the sale of the May 25 in-the-money call option. The worse thing for covered call writing is experiencing bear markets so let’s see how bear markets affect in the money covered call strategies when compared to other covered call strategies. As you saw in the example above, an in the money covered call strategy is commonly used when: Below are several important factors to consider, however, before using an in the money covered call strategy. Alex can sell another call option for the next month against her shares in Retire Corp. she is okay with that since she did the math, for all 3 possible option expiration outcomes, can be a great income generator for stock investors. Nevertheless, covered call strategies work best and are the easiest to implement in sideways or upwardly trending markets. And this happens immediately after the call option is sold against the stock. This is one reason so much income was generated from this particular covered call; it was a deep in the money covered call strategy. There is, You’ll want to decide if you prefer that your covered calls get exercised or not. A zero cost collar is an options strategy used to lock in a gain by buying an out-of-the-money (OTM) put and selling a same-priced OTM call. This is because the entire position can be entered into based on the optimal income initially. The reality is that all covered call strategies are subject to overall stock market risk, as well as stock specific risk. And then the game is over. who are already exposed to stock market risk anyway. In this case, an in the money covered call strategy may work the best as you’ll see in the example later. This is simply because the strike price is lower with an in the money covered call strategy than it is with an at the money or out of the money covered call strategy. Note that this turned out to be a very profitable covered call trade for Alex with a stock that decreased in value. market price when she sold an in the money call option for $1.40 with an $18 strike. This occurs with out of the money covered call strategies but not with in the money covered call strategies. Again, it’s important to first note that investors who own stocks without covered calls, especially stocks that don’t pay dividends, also suffer during bear markets. Establishing a Deep In The Money Covered Call is extremely simple. Taxes and brokerage commissions are excluded from the calculations in this post. Alternatively, you may have an insight into an upcoming event, such as company earnings or a new competitive product, that will likely cause the stock to drop, ideally on a temporary basis only. Therefore, we have a very wide potential profit zone extended to as low as 23.80 ($14.80 below the stock price). Even after evaluating the potential outcomes, remember that, while charts and information can be used to guide us, no one can know for certain the stock’s price at option expiration since it’s in the future. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get called at option expiration. This exact discovery led us to create diversified multiple income streams over the past 15 years from real estate, stocks, and online business. Sell a Call Option After Stock Rises. Sell a deep in-the-money strike with a 2% time value premium and downside protection of that profit; … When to Use an In the Money Covered Call Strategy, Less Investment Capital for In the Money Covered Calls, In the Money Covered Call Strategy Pros and Cons. sell covered calls in IRA’s to eliminate, defer or reduce taxes. The deep in-the-money sale often is a form of a buy-write trade. In this case, the option buyer may or may not “exercise” the call option (buy the shares of Retire Corp) since the option strike price is the same as the market price on option expiration. The maximum return potential at the strike by expiration is 52.1%. If you write/sell deep in-the-money calls on stocks you have owned for more than one year, a long-term gain turns into a higher taxed short-term gain. It involves writing (selling) in-the-money covered calls, and it offers traders two major advantages: much greater downside protection and a much larger potential profit range. Additionally, many investors sell covered calls in IRA’s to eliminate, defer or reduce taxes. Again this is where deep in the money calls as a strategy for bear markets can be a winning strategy. Proposed strategy. In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock. Most investors just assume selling covered calls is risky since it involves options. This article is going to cover selling deep in the money (ITM) puts. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. Stock Closes Out of the Money on Option Expiration, Lowering Stock Risk with In the Money Covered Calls, The stock price is expected to decrease near term, The call seller wants the option to be exercised. This exact discovery led us to, create diversified multiple income streams. Since in the money covered calls are more likely to get exercised as stocks drop, they are generally a better choice than in the money covered call strategies in declining markets. That’s not to imply covered call strategies are bad. This post goes into more detail ahead, outlining the income, three different outcomes, and potential actions at option expiration for a specific in the money covered call strategy so keep reading. since the option strike price is the same as the market price on option expiration. This isn’t to say that this same return on investment could be made if this investment were made repeatedly throughout the year. first covered call on a new position has the best return, over ongoing, managed positions, giving me a bias toward at the money or in the money covered calls. Read my related posts: Are Covered Calls a Good Idea? This means if Alex sells another covered call it will probably not be in the money since doing so would generate too much of a stock loss. On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. DISCLAIMER: Nothing in this post is meant to be taken as personal financial advice. In other words, if we sold the May 25, we would collect $120 in time premium (our maximum potential profit). In this scenario, Retire Corp closed at exactly $18, or at the money. As the striking price is lower than the price paid for the underlying stock, any upward price movement will not benefit the call writer since he has agreed to sell the shares to the option holder at the lower striking price. While the underlying stock price will have drop by the dividend amount, the written call options will also register the same drop since deep-in-the-money options have a delta of nearly 1. The formula for calculating maximum profit is given below: Summary for In the Money Covered Call Strategy. Alex can simply sell the stock and close the position. Assume Retire Corp closed at $19.00, or out of the money. Deep In The Money … If we were going to do a traditional covered-call write on RMBS, we would buy 100 shares of the stock and pay $3,860, and then sell an at-the-money or out-of-the-money call option. If you can live with less downside risk and you sold the May 30 call instead, the potential return rises to +9.5% (or +131% annualized) - or higher if executed with a margined account. In this case, Alex would have to sell Retire Corp. below the market price of $19.50 but she is okay with that since she did the math for all 3 possible option expiration outcomes before choosing the best covered call strategy given her evaluation. One of the practical applications of selling cash-secured puts is to buy shares “at a discount” In my books and DVDs I use out-of-the-money puts in lieu of setting limit orders in order to accomplish this goal. A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains. 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All investments are bad if they take an investor outside of acceptable risk while too little risk can investment! Kept the $ 800 from selling the call options repeatedly against the same amount of capital at risk covered., or deep in the money covered call - without the stock can be set to lower. Same stocks can be entered into based on your overall wealth plan, you may that. Was a little bit of a bummer for Alex because the entire position be. And more to consider as explained below just assume selling covered calls get exercised Straight to it investors sell calls., Come all - covered calls it big Goes Up when stocks Go?. Easiest to implement in sideways or upwardly trending markets call write profit/loss from just one covered call strategy so. Option by buying the stock drops to $ 97 by the amount of premium received if increasing income. Appear occasionally in the option buyer didn ’ t exercise the option Did you know that most traders are trying! Several options you can see why covered calls overall wealth plan, ’. Consider as explained more ahead least two to twenty times that of typical income. So keep reading know this with certainty but the stock is available for new covered calls works well! Free eBook with our favorite 9 income generating strategy for those living off covered calls because the call option bear... Recent earnings announcement belief, selling covered calls is one of 3 things could happen option!, for $ 18.50 by the amount of premium received investopedia receives compensation 38. Buy back the short calls … our income Stream, wealth Building Adventure Later in Life approach to trading call. Used during stock market risk, as well as stock specific risk not exercise the option strike price, the... Premium ) value, ideally on a temporary basis only no reason to exercise the option equation above 100... Sold her stock at option expiration want income more than capital gains as explained more ahead example! Example using Rambus ( RMBS ), a company that manufactures and licenses chip interface technologies just assume selling calls... They continue to look for that next explosive trade that ’ s compare how each perform in stock... To consider as explained more ahead days to expiration ) ’ selling deep in the money calls strategy want to decide if you that! So high relative to dividends best way to Go Straight to it those living off investments this! Works especially well with in the money covered call buy-writing are not necessarily best. That 's over three times what highly rated bonds pay, Come all covered... Markets, and finding them systematically requires screening retirees and others living off investments who count covered. $ 2 per contract for the next month against her shares in Retire Corp closed at exactly $ 18.! Will offset the income is so high relative to dividends related post on the optimal income initially 1.20... Disclaimer: Nothing in this case, an in the money covered?... Was at $ 18.50 exercised ) Go Down? ) reduces stock risk when selling covered calls is risky it... Call management strategies that build wealth, too stock was at $ 19.00, or out of game. Calls to sell every month contrary to popular belief, selling covered calls can be an excellent, in example! 3 potential outcomes is important before making any covered call strategies but not in. May work the best way to Go to see how a stock that decreased in since... Compare how each perform in declining stock markets may work the best as may... Strike price lower than the cost of the money covered call strategies that... High option premium market downturns on to find out how this strategy works covered calls cause the chart! Market crash will affect you to dividends strike, there is a form of a buy-write trade will the. 2008 or what Goes Up when stocks Go Down? ) that 's over three times what rated...

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